The Bank of PayPal

Every few hours at the eBay Live! conference in Boston, the audio speakers explode with Kool & the Gang's song Celebration. For eBay's (EBAY) executives, it's a way of reminding everyone that, despite declining growth in its main shopping business, the company has reasons to party.

Reason No. 1? PayPal. If eBay Live! is a celebration, then eBay's online payment service is the guest of honor. PayPal's first-quarter revenue grew 31%, to $439 million, at a time when eBay's core shopping business grew just 23% and active buyers and sellers grew 10%. PayPal is proving that its success, while connected to the growth of eBay's shopping sites, is not solely dependent on it.

Top executives used their keynote speeches on June 14 to announce new PayPal security initiatives, including a service for eBay sellers that will alert them to potentially risky buyers. The company also announced an eBay site redesign intended to improve auction search results while making it easier to view product photos and details about the auction.

PayPal has designs on the greater e-commerce market, which is expected to top $300 billion in the U.S. alone by 2010, up more than 50% from current levels. Last year, PayPal processed about 6% of all online payments worldwide. And in the first quarter, roughly 40% of the $11.36 billion in payments that PayPal processed originated on sites other than eBay's shopping properties. "The off-eBay business will, at some point, eclipse the on-eBay business," says Scott Thompson, PayPal's chief technology officer.

PayPal's PlasticIn the off-eBay world, most purchases are still made with credit and debit cards, so PayPal's main rivals for online dollars are Visa, MasterCard (MA), American Express (AXP), and the banks that issue their cards. Though PayPal has a lofty 143 million accounts, Visa has more than a billion.

To compete with banks, PayPal is becoming more like a bank itself. For the past year, PayPal has tested a virtual debit card enabling users to make purchases with PayPal on Web sites that do not offer it as a payment option. The service, which PayPal plans to launch broadly before the holiday shopping season, provides a one-time MasterCard number for a given purchase. The money is then debited from the user's PayPal account.

Also like a bank, PayPal has long doled out interest on balances left in PayPal accounts. The rate, often more than 4%, is typically higher than that offered by brick-and-mortar banks. It also offers actual plastic credit cards, through a partnership with GE Consumer Finance (GE), for which it gives buyers 1% back on transactions. In addition, PayPal allows users to wire money through eBay's Skype online phone service. There also are plans to give users the ability to view receipts for past transactions online, says Thompson.

Google Backs DownLast month, PayPal received a banking license with the Luxembourg bank authority. Starting July 2, all European accounts will be transferred to the PayPal Luxembourg bank. (PayPal is not regulated as a bank in the U.S., in part because its services are offered in conjunction with regulated entities such as GE and MasterCard.)

PayPal's bank-like extras have given it an edge over services such as Google Checkout (GOOG), which does not offer credit cards or interest on deposits. Despite aggressively promoting Checkout to its search advertisers, Google has yet to match PayPal's strength or popularity. Google blames this partly on eBay's refusal to allow Checkout as a form of payment on eBay's auction and shopping sites (see BusinessWeek.com, 1/25/07, "eBay Holds Its Turf Against Google").